Both National and Act want to get rid of the Reserve Bank’s ‘dual mandate’. But what does the central bank’s focus on both unemployment and inflation really mean in practice?

So I’m hearing that the Reserve Bank has a dual mandate. 

Yes, throughout the election campaign the National Party linked the Reserve Bank’s dual mandate to the cost of living crisis. The party said the dual mandate was an “experiment” that distracted the bank from maintaining price stability. With the latest unemployment figures from Stats NZ imminent and a nascent new government, the dual mandate is in the spotlight. 

Right, so that’s why I’m hearing about it. But what is it? 

The Reserve Bank is New Zealand’s central bank, which means it is responsible for monetary policy (the rules for lending money, how banks are regulated, how much the value of the New Zealand dollar is changing relative to other currencies). It’s different from the Treasury, which is in charge of fiscal policy (how much money the government has and where it should be spending it) . 

One of the Reserve Bank’s goals, set by its Monetary Policy Committee Remit, is controlling inflation, which it does by changing the Official Cash Rate (OCR), which is the interest rate at which banks can borrow money. Banks use this to help set their interest rates on loans (as well as on savings accounts). The general idea is that when the OCR increases, that increase is passed on to consumers, who then have to spend more on servicing their debts so have less money to spend on other stuff – and less consumption in the economy helps bring inflation down.  That’s the reason that seven times a year there are headlines about the OCR, when the Monetary Policy Committee (MPC) meets and decides whether they should change the OCR or not. Reducing inflation – which is a general rise in the prices of goods and services in an economy – in itself is seen as important for a bunch of reasons but especially because New Zealand imports lots of essential items including food and fuel, which all becomes more expensive if our dollar is worth less. 

But in 2018, the Labour government added a second outcome that the Reserve Bank needs to focus on – maximum sustainable employment. This is the “experiment” the National press release is referring to: asking the central bank to both maintain the value of the New Zealand dollar and, in effect, reduce unemployment – which don’t necessarily go hand in hand. 

Before you go on, I just want to check that there aren’t going to be more acronyms. 

FAOOSIHN. (For all of our sake I hope not.) 

As I was saying, having this “dual mandate” can be seen as contradictory, especially since the biggest lever the Reserve Bank can pull is the OCR, which can only do so much. Controlling inflation means reducing economic activity as the cost of borrowing becomes more expensive (so people save rather than spend), and that can reduce employment. That said, the relationship between inflation and employment is not perfectly linear. 

At the same time, having a dual mandate for the central bank isn’t unique: both the US and Australia have similar policies. (Australia’s Reserve Bank actually has a triple mandate – it is required to keep the currency stable, maintain employment and ensure “the economic prosperity and welfare of the people of Australia”). 

Right, reducing unemployment and inflation at the same time – what does that actually look like in practice? 

It’s hard to tell. The bank has said that changing the interest rate has little effect on employment in the long run. In BusinessDesk, David Chaplin writes that having a dual mandate “doesn’t seem to have made much difference, aside from some extra comms work”. The dual mandate links the actions of the Reserve Bank with the labour of workers who produce value in the economy – but as New Zealand is also affected by the global economy, the bank can only make so much difference. Perhaps it is symbolically important that the central bank has a focus on people, not just on dollars. 

Regardless, as The Bulletin explored earlier this week, both National and Act don’t like the dual mandate and want to get rid of it – ideally within the first 100 days of the new government. While most experts are sceptical that removing the double mandate will have any direct, or at least immediate, material effect on either unemployment or inflation, the new government, just like the old one, might be willing to carry out that experiment anyway.